Approach structured products with caution
Financial advisers are increasingly recommending that clients include structured products in their portfolios - but they should still be cautious when investing in them.
According to a survey carried out by Morgan Stanley, these investments are now preferred by 76% of IFAs. In comparison, just 55% preferred structured products in a previous survey from December 2008, when both bonds and funds were more popular choices.
Structured products combine traditional investments, such as equities and bonds, with derivative products that provide some element of protection or guarantee. They come in various forms, but in light of the recent market volatility, it's unsurprising that the most popular type - preferred by 86% of IFAs - are those that protect your original capital.
Yet the two years since the credit crunch hit have been difficult for these products; backed by large financial institutions, there have been concerns that some might not be able to honour their guarantees.
Investor confidence was badly damaged by the folding of Lehman Brothers and near-collapse of insurance giant AIG a year ago, and more questions about risk were raised when the structured product specialist Keydata Investment Services went into administration in June this year.
So, even though demand is increasing, investors should remain cautious.
Morgan Stanley's survey shows that the main reason given by IFAs for not using a particular structured product is concern over the credit ratings of the counterparties backing it.
"They have a place as part of a balanced portfolio for lower-risk clients, if the counterparty risk stacks up," says Mike Horseman, chief executive of IFA Cockburn Lucas.
But Anna Sofat, chief executive of IFA Addidi Wealth Management, is less convinced.
"They're a big sell at the moment, but I'm jaundiced about them on the grounds of transparency and cost, and some of them have such a lot of small print," she says.
Structured products offer returns based on the performance of underlying investments. Many products are linked to a stockmarket index such as the FTSE 100 or a “basket” of shares. There are generally two types of product, one offers income, the other growth and investors have to commit their capital for the prescribed term, usually three or five years. The investment is not guaranteed and if the index or basket of shares does not perform as expected over the term the investor might not get back all their capital.
A financial adviser who is not tied to any financial services company (such as a bank or insurance company) and is authorised by the Financial Services Authority (FSA). They can advise on financial products to suit your circumstances. All IFAs have to give consumers the choice of paying by fees or commission and have to explain which would best suit the customer in that particular instance. Also, if commission is paid either by the client or the financial service provider recommended by the IFA, the IFA must disclose what that commission is.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
A financial instrument where the price is “derived” from a security (share or bond), currency, commodity or index. The price of the derivative will move in direct relationship to the price of the underlying security. They often referred to as futures, options, warrants, interest rate swaps and contracts for difference (CFDs). They are mainly used for financial certainty – to protect against spikes in the prices of commodities – as a hedge, whereby investors can buy a derivative that bets the market will move against them so they protect themselves against potential losses. Derivatives are also a tool of speculation as they enable banks, traders or investors to bet on price movements without having buy the actual physical assets. As derivatives cost only a fraction of the underlying asset price, they are “geared” (leveraged in the USA) so if the price of the asset moves £1, the value of derivative could change by £10.